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Unit 1: Introduction to Auditing

Pre-trial Ruling Notes

In a pre-trial ruling in early January 2002 on a motion to dismiss, without deciding the
final outcome, the court found that E&Y was potentially legally subject to claims of breach
of fiduciary duty and punitive damages arising out of a failed software implementation
by CGEY, a company in which apparently E&Y is a substantial owner. (The was no allegation
or showing of a failure to exercise the skill and care of a reasonably diligent accountant, so
the court noted that there were no claims of professional malpractice (whether relating to
accounting or computer consulting).
Alleged Misrepresentations by Accountants

The alleged facts of the case, if true, would be particularly egregious. The following
reports are provided according to the court’s pre-trial decision. Whether the allegations
will be proven remains to be seen. In June 2000, E&Y recommended to a client, a medical
and nutritional company, to retain CGEY as the vendor to implement a commercial
off-the-shelf software package that the client had selected, based on E&Y’s recommendation,
for its short and long-term business needs. E&Y made a number of representations to the
client to induce the client to hire CGEY, and the court concluded that, without those
representations, the client would probably have selected another IT service provider. E&Y
reportedly represented that (1) CGEY was competent, experienced and qualified to
implement the system selected by E&Y, and (2) CGEY’s performance of services had
already been “coordinated” with E&Y.
Existence of Fiduciary Duty

A fiduciary relationship existed between the accounting firm and its client for several
reasons. First, the client had developed a relationship of trusting the accounting firm’s
judgment based on prior professional services. Second, the accounting firm offered to
provide additional consulting services. Third, the medical and nutritional company was
less sophisticated than the accounting firm in the “specialty” for which the accounting
firm and the services firm were hired.
Potential Breach of Accountant’s Fiduciary Duty
Thus, “when a fiduciary fails to disclose personal interests preliminary to contract, and/or
represents the existence of a questionable competence and experience critical to the contract
and procures a benefit such as that alleged to E&Y and the newly formed CGEY, the risk of
liability for the negligent misrepresentations and a question of fraud is properly alleged.”
Atkins Nutritionals, Inc. v. Ernst & Young, LLP, NYLJ, Jan. 10, 2002. Accordingly, a fiduciary
relationship arose and could have been breached if proven at trial.

Questions:
1. What you have observed about code of auditing standard followed in Cap Gemini
and Ernst & Young deal?
2. What misrepresentations by accountants had been discovered?

3. Analyze the case in your own words necessitating the need of auditing.
Source: Outsourcing-law.com

1.9 Summary

 The word ’Audit’ is originated from the Latin word ‘audire’ which means ‘to hear’.
 In the earlier days, whenever there is suspected fraud in a business organization, the
owner of the business would appoint a person to check the accounts and hear the explanations
given by the person responsible for keeping the account and funds.

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